Case Study in Supply Chain Optimization

The Benefits of Using a CoQ Indicator to Reduce Costs

This case study was developed by a leading materials manufacturer to determine the cost of quality to their company and evaluate the benefits of developing a supply chain optimization program. The CoQ cost model implemented here was developed by a world leading chip manufacturer, and is analogous to the model used by Linx Consulting supply chain optimization expert Kyle Flanigan.

Quotes on the Cost of Quality

Costs do not exist to be calculated; costs exist to be reduced.
— Taiichi Ohno

Cost is more important than quality, but quality is the best way to reduce cost— Genichi Taguchi

There’s never enough time to do it right, but there’s always enough time to do it over. – Jack Bergman

What is the cost of quality (CoQ)?

CoQ is any cost that would not have been realized if quality were perfect. In a perfect world, the product would be flawless every time, and there would be no reworking costs. Unfortunately, in the real world, this is rarely the case. It’s when the product doesn’t meet requirements on the first attempt that the costs start to mount. Every time work is redone or a product fails to meet requirements, the cost of quality increases.

Research shows that COPQ can be 15-40% of business costs due to:

Rework

Returns/complaints

Lost revenue

Reduced service levels

Can you afford to ignore the cost of quality?

Finding and correcting mistakes can be costly, and as a result, most businesses don’t know their CoQ. Without a clear understanding of what the actual CoQ is, it’s difficult to fully understand the impact quality has on the bottom line.

In the long run, materials suppliers that invest more time and money in the beginning of the process to improve quality are more profitable. The cost to eliminate supplier failure is typically 5x greater than in development or manufacturing. Consequently, the earlier an error is found and corrected, the less it costs. With a little forethought and planning, quality can significantly improve profit margins, reducing failure and rework costs for both supplier and manufacturer.

How can you lower the cost of quality for your company?

To lower the cost of quality, material suppliers should take these steps for each new product:

Conduct a thorough design review

Raw material risk mitigation

Process characterization

Although this process costs more upfront, the benefits of addressing these issues can eliminate costly adjustments later in the process, in addition to increasing profits. Failure to plan can result in loss of $millions for wire defects, dot defects, coherence excursion, and other failures.

The Total Cost of Failure to Meet Supply Chain Expectaions

The "tip of the iceberg" graphic above illustrates the costs that can add up to 20- 40%of business costs, whereas prevention costs average 5-10% of costs.

Case Study Overview

Problem / Opportunity

Supplier doesn’t track how much it costs to prevent, find, and handle failures in a consolidated manner. Understanding these costs requires visibility into the entire value chain and product life cycle.

Goal/Vision

To have quality cost targets in place based on a standard cost model that:
1) shows the total financial impact of poor quality and;
2) can be applied to any product line.

Stakeholders

Any group responsible for the development, manufacturing, and support of a product throughout the product life cycle.

CoQ Findings

Prevention and appraisal components can (and should!) be planned and controlled to lower failure cost.

Step 2 - Set goals for CoQ

Once the total CoQ was identified, the company set goals for reducing costs as follows:

Goal = Reduce cost of quality

Cost Diagram

A marginal cost of quality analysis was developed to determine if the company was operating at the optimal point.

Step3 — Mapping the CoQ to the PLC

The next step was to map the CoQ to the PLC to begin monitoring the costs of quality at each stage of the manufacturing process.

CoQ Overview

Prevention Costs

Prevention costs include all activities specifically designed to prevent poor quality in products or services such as:

New product review

Quality planning

Supplier capability surveys

Process capability evaluations

Quality improvement team meetings

Quality improvement projects

Quality education and training

Appraisal Costs

Appraisal costs include measuring, evaluating or auditing products or services to assure conformance to quality standards and performance requirements such as:

Incoming and source inspection/test of purchased material

In-process and final inspection/test

Product, process or service audits

Calibration of measuring and test equipment

Associated supplies and materials

Failure Costs

The failure cost includes all costs resulting from products or services not conforming to requirements or customer/user needs. Failure costs are divided into two categories — internal and external, based on whether they occur before or after delivery to the customer.

Internal Failure Examples:

Scrap

Rework

Re-inspection

Re-testing

Material review

Downgrading

External Failure Examples:

Processing customer complaints

Customer returns

Warranty claims

Product recalls

CoQ Model

Cost of Quality =Cp +Ca +Cif +Cef +Caf

Cp = Cost of Prevention

Ca = Cost of Appraisal

Cif = Cost of Internal Failure

Cef = Cost of External Failure

Caf = Cost of Administrative Failure

Cost of Prevention

Cost of Prevention is usually the smallest component of CoQ. XYZ supplier has evolving prevention costs, but current prevention costs include:

Cost of Administrative Failure

Program Results

CoQ Trend as Absolute $$$

Customer Compensation for Product Performance

CoQ Trends as % of Total Revenue

Return on Quality (ROQ)

Summary

The materials supplier created a standard cost model to be applied to all product lines with cost targets for all quality costs to assess impact of quality on profit margins. The cost model was mapped to the PLC and tracked over a two-year period with the following results:

Customer Compensation for product performance was reduced 6%

Total cost of quality was reduced 51%

Appraisal costs were reduced 45%

Total failure costs were reduced 80%

External Failure costs were reduced 83%

Total return on quality was 345%

The Benefits of a CoQ Model

The material supplier identified the following benefits of applying a CoQ model to monitor quality costs:

Links quality to the bottom line

Spending on quality is necessary to produce, market, and sell a product

Quality costs are just as relevant as material costs, design costs, and manufacturing costs

Costs can be proactive or reactive; CoQ can be a lever to drive down total costs through continuous improvement and value-added investments in proactive costs

Improves visibility and accountability for key CoQ components

Show quality cost trend over time

Highlight opportunities for improvement

Evaluate the effectiveness of investments in quality activities

The effects of quality spending are typically long-term, so there can be a lag between quality “investment” and the downstream benefit

Provide baseline for “what-if” scenarios

Historical data can be used to establish cause/effect relationships between different quality costs

Provides a framework for analyzing quality-related issues

Improve your company’s profit margins with a CoQ model

Although materials suppliers are starting to realize the benefits of implementing a CoQ model to lower quality costs and increase profits, many suppliers haven’t addressed this issue. With manufacturers pushing quality into the supply chain, materials suppliers must develop their own programs for supply chain optimization if they want to maximize profits and sales.

Unfortunately, many small and medium suppliers don’t have the resources to set up CoQ model to monitor quality costs, but would like to increase profit margins. If you would like to implement a CoQ model to monitor your company’s quality costs, Linx Consulting can help. Linx supply chain optimization expert Kyle Flanigan has implemented the above CoQ model for various materials manufacturers with excellent results.